Fed not seen cutting rates until December amid tariff uncertainty

Deutsche Bank analysts anticipate the Federal Reserve will maintain its current interest rate stance due to uncertainties surrounding the inflationary impact of potential tariffs, projecting a resumption of rate cuts in December 2025 followed by two additional cuts in Q1 2026, ultimately reaching a neutral rate of 3.625%. This outlook contrasts with market expectations, as reflected in the CME FedWatch Tool, which currently indicates a 54.7% probability of a 25 basis point rate cut in September, while upcoming CPI data is expected to show a slight increase in inflation, potentially influencing the Fed's decision-making process.

Analysis

Deutsche Bank analysts project the Federal Reserve will maintain a cautious, data-dependent stance, delaying the resumption of its rate-cutting cycle until December 2025, with two subsequent reductions anticipated in the first quarter of 2026, aiming for an estimated neutral borrowing cost of 3.625%. This forecast diverges from current market sentiment, where the CME FedWatch Tool indicates a 54.7% probability of a 25-basis-point rate cut as early as September. The Fed's hesitancy, keeping rates at a 4.25% to 4.5% range, is attributed to significant uncertainty surrounding the inflationary consequences of potential U.S. tariffs, which economists warn could elevate prices and negatively impact economic activity. While recent strong U.S. employment data for May suggests underlying economic resilience, upcoming May Consumer Price Index figures are expected to show a slight acceleration in headline inflation to 2.5% year-over-year and core inflation to 2.9% year-over-year, providing critical inputs for the Fed's near-term policy trajectory. The prevailing mildly negative sentiment and uncertain tone underscore the complex interplay between trade policy risks and monetary policy normalization.

Key Decisions for Investors

• Investors should closely monitor upcoming inflation data, particularly the May CPI and subsequent producer price and consumer expectation reports, as these will be critical in shaping Federal Reserve policy and market expectations.
• Given Deutsche Bank's projection for a delayed start to rate cuts until December 2025, significantly later than current market pricing, investors may need to reassess timelines for monetary policy easing and its impact on interest-rate sensitive assets and overall market valuations.
• The pronounced uncertainty surrounding the inflationary effects of potential U.S. tariffs warrants a cautious approach; investors should consider the implications for sectors sensitive to trade policy and inflation, and potentially review portfolio defensiveness against policy-induced volatility.